OREANDA-NEWS. Fitch Ratings has affirmed Arqiva Financing plc and Arqiva PP Financing's whole business securitisation (WBS) bonds at 'BBB', and Arqiva Broadcast Finance plc's high-yield (HY) bonds at 'B-'. Fitch has revised the Outlook on the HY bonds to Negative from Stable. The Outlook on the WBS bonds is Negative.

The affirmation of the WBS bonds mainly reflects their expected gradual deleveraging, in line with their largely contracted revenue profile and solid resilience to RPI and Libor sensitivities. We expect net senior debt-to-EBITDA under Fitch's base case to fall to around 3.0x in FY25 (financial year ending June) from 5.8x in FY16 and to close to 0x in FY30. This is broadly in line with our previous reviews. The deleveraging profile of the HY bonds is consistent with previous reviews, falling to 6.4x in FY20 at maturity from 7.1x in FY16.

The Negative Outlooks reflect the remaining uncertainty from Arqiva's strategic overhaul, together with the recent operational restructuring and departures of key personnel such as, in 2015, the CEO, CTO and MD of Digital Platforms and, in 2016, the CFO (already replaced in May with an experienced executive). However, Fitch understands from Arqiva that it aims to increase its focus on more core infrastructure assets, which could be credit positive.

Fitch understands that a refinancing plan for the remaining GBP353m of finco term loan B (TLB) outstanding is currently in progress. Until it is completed, the TLB will benefit from a 75% cash sweep from June 2017. The HY notes need the TLB to be refinanced relatively soon, as from March 2018, the cash sweep will increase to 100%, thereby disallowing any dividends to be paid out to service their debt service.

We could revise the Outlook to Stable once we receive in FY17 further clarifications of both the group's strategy over the longer term with additional confirmation of the cost-savings sustainability and the refinancing of the TLB.

Arqiva's financial performance was in line with Fitch's base case with FY16 EBITDA expected to grow by over 1%, in line with the company guidance of GBP425m, thereby marginally outperforming Fitch's base case by 1%. The operational transformation plan initiated last year with the appointment of a Chief Transformation Officer has resulted in cost savings in FY16, which management expects to reach over GBP30m on an annual run-rate basis. Arqiva's order book remains strong at GBP6.2bn. Fitch's base case free cash flow synthetic debt service coverage ratios (FCF DSCRs) between FY16 and FY33, are at around 1.5x.

KEY RATING DRIVERS

Fitch has assigned the following attributes to the three key rating drivers (and relevant sub-KRDs) as per Fitch's UK WBS criteria.

Industry Profile: 'Stronger'

(Operating Environment: 'Stronger')

Arqiva is the sole UK national provider of network access and managed transmission services (regulated by Ofcom) for terrestrial television and radio broadcasting. The company owns and operates all television and 90% of the radio transmission towers used for digital terrestrial television (DTT) and terrestrial radio broadcasting in the UK. Arqiva has long-term contracts with public service broadcaster customers who depend on Arqiva to meet the obligations under their licences to provide coverage to 98.5% of the UK population as well as with commercial broadcasters. Arqiva also owns two of the three main national DTT commercial multiplexes (out of a total of six) plus two new (HD-compatible) DTT multiplexes. Similarly, Arqiva owns one national commercial digital radio multiplex and, since March 2015, 40% of the second.

Arqiva is also the largest independent provider of wireless tower sites in the UK, which are licensed to the mobile networks operators (MNOs) and other wireless network operators, with approximately 25% of the total active licensed macrocell site market (as of end-March 2015).

Embedded in its industry nature, Arqiva is not exposed to discretionary spending and we do not view its sector as cyclical.

(Barriers to Entry: 'Stronger')

The industry's barriers to entry are viewed as high, notably due to the stringent regulatory framework and the industry's capital-intensive nature.

(Sustainability: 'Midrange')

Arqiva is exposed to potential changes in technology in the medium to longterm with, for instance, the emergence of new means for content delivery (e. g. IPTV), which may affect pricing, in particular in the DP and satellite and media divisions (each representing over 15% of Arqiva's revenues).

Company Profile: 'Midrange'

(Financial Performance: 'Midrange')

Arqiva's trading history has been strong overall with past reductions in revenues typically having been compensated by gains in margins. Since FY08, EBITDA, in particular, had grown strongly at a CAGR of 7.7% until FY13, when performance turned subdued, CAGR dropping to 0.8%. The EBITDA margin is also expected to decline marginally to 49% in FY16 from a peak of 50.8% in FY13.

(Company Operations: 'Midrange')

Fitch views positively the company's operations, as Arqiva has constantly met its various key contract operating obligations. Over half of Arqiva's revenues are generated from long-term contracts (typically RPI-linked with no or little volume risk) with counterparties with strong credit ratings such as the BBC, large MNOs and utilities companies.

Arqiva's sponsors are large and experienced infrastructure funds with a long-term view. However, the company has seen some recent significant changes in management with the departures of the CEO, CTO and the MD of DP in 2015 and the CFO in 2016. The board also previously added a management board position of Chief Transformation Officer December 2015 to drive the business transformation programme. This corporate restructuring adds some short-term uncertainty, which Fitch will closely monitor.

(Transparency: 'Midrange')

Good insight into the financials and operations of Arqiva is balanced by the inherent complexity of the operations, which hampers its transparency.

(Dependence on Operator: 'Weaker')

Given the specialised and complex nature of Arqiva's operations, there are only a few alternative operators capable of running its secured assets, which diminishes the value of administrative receivership.

(Asset Quality: 'Midrange')

Assets of this nature are very infrequently traded and there are no alternative values, but assets can be disposed of on an individual basis or on a going-concern basis. Maintenance capex is generally well defined but timing and exact funding amount could be uncertain.

WBS Bonds - Debt Structure: 'Midrange'

(Debt Profile: 'Midrange', Security Package: 'Stronger', Structural Features: 'Midrange')

The senior debt is fully amortising by either cash sweep or following a fixed schedule. There are many large swaps present due to legacy positions, notably super senior index-linked (IL) swaps and index-linked swaps overlays and other interest rate (IR) and FX swaps, which adds to the complexity of the debt structure. These IR and IL swaps essentially slow down any deleveraging due to either potentially incurred IR swap breakage cost following cash sweeps or IL RPI accretion paydowns, which occur every three years until 2027.

Some senior loans are also exposed to some interest rate risk past their expected maturities. The senior debt also contains many prolonged interest-only periods, which is credit negative.

The senior debt benefits from a typical WBS security package, namely, first ranking security over freehold/long leasehold sites with the possibility of appointing an administrative receiver. The senior debt benefits also from a comprehensive set of covenants and cash lockup triggers set at moderate levels. The issuer liquidity facility covers only 12 months of debt service. The issuer is not an orphan SPV. However, we deem the potential conflicts of interest due to the non-orphan status of the SPVs and their directors also being directors of other group companies remote and consistent with the notes' ratings, given the structural protections in the transaction's legal documentation.

HY Bonds - Debt Structure: 'Weaker'

(Debt Profile: 'Weaker', Security Package: 'Weaker', Structural Features: 'Weaker')

The HY bonds are bullet. They are deeply structurally subordinated and would default if dividends pay-out from the WBS group is disrupted for more than six months. We view their security package as weak as it consists of share pledges over holding companies with no second lien security over the WBS security package. The covenants and lockup triggers are comprehensive but are set at low levels. The issuer's liquidity cash reserve account covers only six months of interest payments.

RATING SENSITIVITIES

Downgrade:

Under Fitch's base case, if net debt to EBITDA is substantially above 3x in FY25 and 0x in FY32, this could result in a downgrade of the senior debt. The HY notes could be downgraded if their refinancing risk increases or if the full cash sweep features embedded in some of the senior debt is close to be triggered.

Arqiva's future cash flow could be curtailed following unfavourable and unforeseen significant changes in regulation by Ofcom with regard to any changes in its pricing formulas, notably for future DTT or radio broadcasting contracts, licensing costs (e. g. administrative incentive pricing) or even spectrum allocations. The risk of alternative and emerging technologies such as IPTV could also threaten Arqiva's revenues, either through technology obsolescence risk and/or lower ad-pool available to linear TV content providers. This risk is currently mitigated by the potentially rapid deleveraging of the transaction assuming cash sweep amortisation and the long-term contracts securing significant revenues.

Upgrade:

Under Fitch's base case, if net debt to EBITDA is substantially below 3x in FY25 and 0x in FY30, this could result in an upgrade of the senior debt. The HY notes are unlikely to be upgraded. Arqiva's future cash flow could be revised up if, for instance, the company signs new long-term contracts or if renewals of existing contracts are renegotiated on better terms than expected.

SUMMARY OF CREDIT

The transactions are the refinancing of senior and junior bank debt of Arqiva Financing No.1 and No. 2 Limited through the issuance of around GBP1,612.5m of WBS notes, GBP180m of ITL and GBP190m of EIB loan, plus around GBP353.5m of Finco term loans (the underlying WBS issuer/senior borrower loans ranking pari-passu with the underlying secured Finco/senior borrower loans, the ITL and EIB loan), and GBP600m of structurally subordinated HY notes. The remaining Finco term loans are expected to be refinanced under the WBS programme.

The rating actions are as follows:

Arqiva Financing plc (WBS issuer):

GBP164m 5.34% Series 2014-1 notes due 2037: affirmed at 'BBB'; Negative Outlook

GBP350m 4.04% Series 2013-1a notes due 2035: affirmed at 'BBB'; Negative Outlook

GBP400m 4.882% Series 2013-1b notes due 2032: affirmed at 'BBB'; Negative Outlook

Arqiva PP Financing plc (WBS issuer - US Private Placement (USPP)):

USD358m (GBP235.5m equivalent) Series 1 guaranteed secured senior notes (WBS) due 2025: affirmed at 'BBB'; Negative Outlook

GBP163m Series 2 guaranteed secured senior notes (WBS) due 2025: affirmed at 'BBB'; Negative Outlook

GBP300m Series 3 guaranteed secured senior notes (WBS) bonds due 2029: assigned 'BBB', Negative Outlook

Arqiva Broadcast Finance plc (HY issuer):

GBP600m 9.5% senior notes due 2020: affirmed at 'B-'; Outlook revised to Negative from Stable